Thursday, January 05, 2012
12:49:07 AM EDT

Bullish Breakout Above a Broad 'Triangle'

by
Leigh Stevens

"I follow the Nasdaq more closely than the other index. I trade NDX options and also follow the Nasdaq composite for guidance. The recent move to new highs in the Dow makes me wonder if Nasdaq will do the same. I even heard talk about Nasdaq getting to 3000 if the economy continues to do better. Anything in what you are seeing that would suggest a major move higher?"

MY RESPONSE:

On a technical/chart basis both the Nasdaq Composite (COMP) and the S&P 500 (SPX) have broken out above symmetrical triangle formations, which is bullish. The S&P 100 and the Dow have gone to new highs for the current advance dating from the August-September lows. SPX is quite close to testing its prior Closing highs around 1285 (as of 1/4/12).

The Nasdaq is lagging like the S&P was lagging COMP back when tech was where the strongest buying was coming in the 2011 first half rally. There is a 'measuring' technique relative to the triangle pattern that suggests the recent upside breakout above the top end of the 'triangle' pattern could lead to an eventual move in COMP to the 3000 area. I rate this kind of advance as a long shot but I'll go into what is suggested by a triangle pattern and we'll see what develops.

TRIANGLE (CHART) PATTERNS

A triangle is a continuation (the prior trend CONTINUES after it completes) pattern that is generally bullish in an uptrend and bearish in a downtrend. However in a sideways trend such as we've seen in the past few months, a chart triangle that forms is 'neutral' until prices break out above or below the two trendlines that form a triangle. After such a technical breakout move, there's an assumption that there will be follow through in the direction of the breakout.

HOW TRIANGLES FORM:

A series of minor upswings and minor downswings trace out two trendlines that slope in the SAME direction, and these two trendlines form a triangular pattern; the two trendlines come together or converge over time.

Each of the two opposing sides of the triangle consists of two trendlines that are traced out by 2-3 highs and 2-3 lows. Whether the triangle itself slopes up, down or is 'symmetrical' as will be shown, will vary. Common to all triangle types however is that after prices get close (within 20-30% or less) to where the lines would touch/converge, prices make a move or breakout above or below the top most or bottom most trendline.

The third 'side' of the triangle is assumed to be the vertical distance between the initial highs and lows of the two trendlines. This third line, closing the triangle, is imagined but not drawn.

A 'symmetrical' pattern, where the two trendline angles converge and have approximately the same slope, is a commonly seen triangle as seen below from my historical chart collection:

Sometimes, there is a sideways movement or a countertrend movement after a breakout of the triangle (in the expected direction of the prior trend) but the eventual outcome is still the same:

You'll note that the trendlines I generally construct are examples of internal trendlines; i.e., the line sometimes 'cuts through' or bisects some extreme lows or highs. An internal trendline connects the MOST number of points or as I sometimes say makes for a 'best fit' trendline.

I learned the term and technique from technical analyst and author Jack Schwager who used to say about trendlines, that he didn't use 'trendlines', but did use internal trendlines, which he found worked the best in defining support and resistance.

Often prices are unable to even return to the trendline that was pierced. An example of a 'symmetrical' triangle is seen with what used to be Phillip Morris (MO), before I move on to the current S&P 500 and Nasdaq Composite charts:

There is a 'measuring' implication for a further move once there's a breakout above or below a triangle formation.

CURRENT SYMMETRICAL TRIANGLES IN SPX AND COMP:

The symmetrical triangle patterns seen with the Nasdaq Composite and the S&P 500 next are ones that formed after an extensive SIDEWAYS move. Therefore, a breakout above or below the upper or lower trendlines doesn't involve a continuation of the PRIOR trend so much as suggest resolution of the trend either up or down. The potential upside objectives involved are highlighted on the SPX and COMP daily charts:

My next chart, that of the current S&P 500 daily chart (as of 1/4/12), assumes that the triangle is 'closed' on the left by imagining a straight line is dropped from 1292 (at the upper trendline) to the lower up-sloping trendline which intersects at 1115. The difference between 1292 and 1115 is what is added to the 'breakout' point to come up with a potential eventual upside target.

Finally, in answer to the question I began with in answer to the possibility of an eventual advance in the Nasdaq Composite to as high as 3000: there is potential for that kind of advance implied by the recent upside breakout above the upper end of the highlighted triangle.

Meanwhile, COMP hasn't yet been able to get back above resistance implied by its 200-day moving average OR to above its prior highs near 2750. So, while a move to as high as the 3000 area seems distant, it wouldn't be a total surprise based on the chart pattern; specifically as seen in the triangle pattern for the Nas Composite.

Stay tuned on how a next move unfolds. To date, rallies have tended to fall short of even modest technical objective.